Tax-Bomb – Incoming

Most Americans don’t realize that a tax-bomb is on its way. It’s scheduled to hit soon after the elections in November. President Obama knows all about it, of course, but he won’t be issuing any warnings until the elections are past. He knows that Congressional Democrats would suffer serious losses if voters knew what’s in store for them.

Why do I know this? It’s not because I have a secret source inside the White House. The reason is much simpler. It’s because I’m a numbers-guy who can see that trillion-dollar-plus deficits far out into the indefinite future are not “sustainable” – to use a favorite term of contemporary political pundits. Verily, a child could see that we can’t keep racking up debt at this rate without breaking the bank. We have to start paying the bills, or else we’ll have to start cutting expenses. This is what families do when outgo exceeds income. Only our federal government seems immune from this, but it’s not reality.

Democrats are banking (so to speak) on American voters’ well-known distaste for spending-cuts. Our enthusiasm always evaporates when the cuts get close to items in which any of us has a personal stake. Spending-cuts always involve log-rolling or horse-trading inside Congress, whereby each member agrees to cut his favorite programs or pork in exchange for cuts of items dear to other members. (It won’t work if there’s any cheating, so you know it’s really impossible.)

Cuts can also be made politically. The party which controls Congress has the power to cut the minority party’s stuff. That this doesn’t usually happen is a testimony to the power of the minority’s threats to do the same thing when they regain power. Better, all around, to let sleeping dogs lie. So nothing happens.

The consequence of these arcane congressional dynamics is that government programs are – as Ronald Reagan once said – “the closest thing to eternal life as you’re likely to see on earth.” This is why the federal budget is now increasing at a gallop, not just a trot or a canter any more. Thirty years ago, President Jimmy Carter’s “lean and tight” federal budget was $525 billion. President Obama’s budget for FY2011 will be about $3.83 trillion (i.e., $3830 billion). That’s a 600% increase in 30 years. Even with accounting for inflation (140% since 1980), Mr. Obama’s budget is 3 times Mr. Carter’s. [1]

If there isn’t much constituency for cuts in the federal budget, there is even less for tax increases. Many of us expected Mr. Obama to be a big spender because all Democrats are. It’s what they do, and it’s how they get elected. But anyone who anticipated lavish spending also saw that BHO would certainly raise taxes once he got a lot of his spending in place. Many voters knew this, and Mr. Obama knew they knew, so he sold his candidacy on the “promise” that no one’s taxes would go up if he made less than $200,000 a year (or $250,000 a year for a married couple).

After Mr. Obama spoke these magic words, Big Media fell into a coma from which they still have not awakened. Very few reporters have checked to see what tax rate would have to be applied to incomes over $200,000 to pay for Mr. Obama’s lavish spending plans. One pundit said a 100% tax rate would still not be sufficient. I don’t know if that’s correct, but the rate would certainly be greater than what high-income earners would tolerate.

Something has to give. One of the following must happen: (1) find more sources of taxation; (2) continue big deficits; (3) reduce spending. The last seems unlikely, and the second is unsustainable. This means Mr. Obama’s solemn promise might also be…er… unsustainable. (I’m sure he’ll have a good explanation – maybe that it’s all George Bush’s fault…)

Even Democrats can see that we are maxed-out on the income tax. That’s why Mr. Obama promised “ordinary” citizens that their taxes wouldn’t go up. He knew most of us wouldn’t think beyond the income tax. The 3 million households making over $250,000 a year will pay higher income taxes for Obamacare, but Mr. Obama can easily risk offending that small sliver of the voters. (They are, after all, "the rich.” Our envy of them is why we have the income tax.)

The real tax-bomb is going to be the Value-added Tax, or VAT as it is called in Europe. This strange creature is more than a mere national sales tax, as some imagine it to be. Instead, it is a cumulative tax that is added to the price of a product at each step of its manufacture and development. Whenever value is added to the product, the tax on that added value (at the VAT rate) gets added to the price. In Germany the VAT rate is 15.85%; in the United Kingdom it is 21%; in Switzerland, 25%. (Please refer to a complete table of VAT rates at http://en.wikipedia.org/wiki/Tax_rates_of_Europe ) This will be far more than our piddling 5% sales tax in Virginia.

The great thing about the VAT, from government’s perspective, is that the true amount of the tax is mostly invisible to the taxpayer. The tax at each level of the commodity’s development simply becomes part of the price. By the time the product reaches the consumer, no one (except government) knows how much tax was added. The consumer might sense that he is paying more than he used to pay for a car or a “widget,” but the VAT usually starts out at a low rate, making the added tax hard to detect. It would almost certainly be introduced to the USA in this way. A rate of 2% would be barely noticeable at first.

Once the VAT really gets cranked up to rates like those in Switzerland, though, it produces rivers of cash with almost zero political pain. Successive congresses and presidents will just sit there dreaming up new “progressive” spending programs as the money rolls in. It is the ultimate dream-tax – hidden, barely noticed, and productive beyond the dreams of avarice. It could crush our economy and greatly degrade our standard of living, but, hey, that’s the price of progress.

In the past, I have written semi-favorably about the VAT because I believe taxing consumption beats taxing income. A consumption tax is elective, to a degree, since consumers don't pay it unless they buy something. High-income earners sometimes can control their taxes by limiting their incomes, but lower earners usually cannot do so because they need all the income they can earn. Thus, the VAT would give lower-income people some control over their taxes.

In addition, the VAT would correct a glaring problem we have allowed to develop with the income tax: namely, that nearly half of all Americans pay no federal income tax. Both political parties have promoted this situation. It was considered compassionate to exempt poorer workers from taxation entirely, but the idea has gone out of control. Many political and economic analysts now warn that allowing a large segment of voters to be aloof from the burden of taxation is fundamentally unsound. This voting bloc can now elect politicians who will promise to tax others, but not themselves, for funding our government. This strikes at the heart of self-governance by exempting some from its costs.

My support for the VAT, however, has always been conditional on one salient point: abolishing the income tax. This would mean repeal of the 16th Amendment to the Constitution. If we fail to take that step, we shall assuredly have both the income tax and the VAT – not a salutary result. This will happen, unless voters have enough sense to replace high-spending, high-taxing senators and representatives with new ones who can rein-in the out-of-control federal Godzilla. It always comes down to the People being the only ones who can save us. Let’s hope they don’t fail here. This one is going to be close.